they should have let them collapse i think. Its not really fair now, what happens to all the small companies that nobody hears about who also owned this stuff? do they plan on bailing them out as well? Another article today suggests maybe they are because Paulson is talking about 100's of billions more now and they are already in for around 800 billion.

Hopefully all those companies will be forced to be far more transparent, in regards to what they are buying in the future, by their investors.

Either way, i dont think this is the end of this. America has got to stop printing money. We also need to stop pricing oil off the US dollar and instead make a new index for it.

Common people paid the price in 1929 with 25% unemployement in the USA. They will pay the price again, somehow. They will pay the price of greed, money lending speculation irresponsability, folly. The will pay for the invisible hand of economic madness. Reagan is dead but Thatcher is alive...

For the last 2 to 21/2-years the most issued CDS was the synthetic CDO. One of the ways of creating this was using credit default swaps as assets to support the tranches the reporter describes. This instrument is mis-understood by the media. The synthetic CDO's do not buy the credit default swaps they issue them to someone who wants to buy protection.

These CDS receive regular premium payments that are used to pay the interest to the CDO's note holders.

Now the real question is how many of these are out there. How many CDS's were created on the Fanny and Fredie debt? With the US government as essentially the owner, who would spend a nickel (Shilling) more for credit protection. Who holds all these soon to be non-performing synthetic CDO's? How much leverage are they still held under?

I do not believe that the economist is being obscure; the subject of the article is obscure. You will not find "CDS" or "CDO" in the Economics A-Z section. You will find derivatives though. What seems to have happened with CDS/CDO/"whatever I can dream up" derivatives is that they were traded as if they were physical things. Derivatives are contracts and all contracts have inherent risks attached. That's why there are so many lawyers. Lawyers try to wish away by writing away risk or they clean up the toxic messes made by the breach of a contract. Deriving a derivative from a derivative so that you can launch yet another derivative may make sense to a theorist. More importantly it may make a lot of money for the people who sell the product, But it can not be explained in simple terms. Worse it makes little sense in human terms. Someone always cheats. Someone always oversells. No one, not even God him/herself, is fully informed enough to accurately price the derived derivative from a derivative as it exists in the fog of the real world. But since these were quantized they had to be safe as apples. Then a bursting bubble occurred. No one understands the derivative to the 2nd or 3rd power. Unable to be valued (almost) they are now (almost) worthless. The financial system has geared itself up by an unknowable, but very large, number by relying on the mortgage assets and other assets. We do not know what other asset classes have gone into the world of quantized derivatives. We still don't know what other class of asset is being quant derived to the third power today and will sold as the new miracle drug a few days from now. It will be an interesting ride.

It is ironic that Mr. Buffet was critical of derivatives since one of his famous and much touted investments was Moodys which, along with S&P, were more responsible than any other entity or person for the losses in the past year.

Is it too much to ask that, instead of discursively mimicking the shadowy derivatives market, The Economist try to present a clear picture of what is happening? What does it mean to say that AIG has a 441 billion USD "exposure" in credit derivatives? Are you referring to insurance contracts that would have been unilaterally voided had AIG gone bankrupt? Are you referring to money--if the detritus that seems to be to be at the root of the present predicament can be called that-- AIG owes or is owed? Can you make an effort not to hide behind vaporous jargon?

"Do you have in mind that they're complex? Or that they're traded?"Complexity and design. The issue isn't that the derivatives market has failed in this situation at this point - it is that derivatives by their nature are another unquantified risk in this environment. As complex synthetic instruments they can represent any combination of risks or outcomes, and depending on the unpredictable nature of the market this can lead to large losses in the market by the players playing derivatives.Options and futures are risky instruments by nature as no one can predict the future with any great certainty - but complex swaps and derivatives exacerbate that risk (with the offer of reward). In and of themselves as a portion of the market they are useful, but like anything else it is when the players are betting to heavy in derivatives in volatile markets you can see large losses. As an example of the risk, we are seeing airlines taking losses in hedging positions against oil futures as they were expecting a $130-150 barrel band in this time frame. That same strategy could be part of a derivative synthetic that some player has bet heavily on looking for increased upside in a volatile market.

i'm amused that commentators will say things like "derivatives are Vegas for Bankers" with nothing to actually back that statement up. Do you have in mind that they're complex? Or that they're traded?

It would be worth bearing in mind that the entire credit crunch was kicked off by mis-valued sub-prime debt, and had nothing to do with derivatives. At no point to date has any part of the derivatives market failed to function, no have derivatives played any significant part in the failures we have seen of financial firms (which instead have primarily been due to mis-pricings of underlying assets).

A good article, but I doubt that many people would buy credit default protection from an investment bank.
More importantly the interest rate swap market actually provides further strength and support to the capital markets.
This is because, almost invariably, it is the stronger (higher rated) counterparty which is paying the floating rate side; and the weaker pays the fixed.
So when rates are high, it is the stronger party which has to carry the burden.

The debt-asset ratios of these investment firms were so fantastically high that the only way the system could continue working was if revenue came in on time so that it could be disbursed on time.Timely flow of revenue was absolutely crucial to the functioning of the system. When revenue stopped flowing in in a a timely fashion at the bottom of the system, it propagated through the system like a wave, causing the top of the system to crash.Why did revenue not flow in on time? Because of speculation driven run-ups in the cost of housing; poor evaluation of borrowers’ true ability to pay; and the continuing rate of growth of income inequality leaving the middle class cash-flow short. By aggrandizing more wealth to themselves in the short term, high income people ensured the collapse of the system that kept them wealthy.As any millwright knows, when the timing system on a machine fails, the whole system comes to a crashing halt.

"Derivatives is essentially a zero sum game. Having a central clearing house would not make the risk go away. It would only shift the risk from one counter-party to the clearing house"

You may be right ... but a clearing house (as any other centralized control system) would provide something that today simply does not exist, i.e. complete information on each participant net positions. a very powerful tool (think of the size and geography of the relevant market) which should be set up and operated by very wise and accountable people ... who are your candidates? ISDA eggheads? the Feds? the SEC? the ECB? the IMF? a new UN-sponsored international financial body? ... no wonder it never materialized!

p.s. please have a look at July 5th cover for more (and less western-biased) possibilities

Warren Buffet seems to be a man of wisdom and vision in a world led by intellectual and moral pygmies. I personally have lost all faith in Gordon Brown. It seems he did not know what he was doing all these years first as Chancellor now as Prime Minister.

These nuclear bombs are all over the world’s financial markets from Japan to Iceland to Poland etc. They are ticking time bombs and only one may have gone off so far with hundreds more to explode over time. The financial landscape of the world will be completely altered by the time this slowly-unfolding global catastrophe has run its course. By the end (many years from now), the Global Economy will be unrecognisable from how it looks today. ‘Change’ is what people say they want and more change than they could begin to comprehend is what they are going to get.

This crazy in the Financial Market with certain was previous of the managers and another peoples that haven't been concerning with them decisious. I believe if the american goverment does a certain something, we'll see the goods results in the future.
To me, the derivatives market should follow the rules of the SEC - To us can live in the society safe !

The article say 'It is doubly troubling that the collapse of Lehman Brothers and the near-collapse of American International Group (AIG) came before such useful reforms as a central clearing house for derivatives were in place.'

Derivatives is essentially a zero sum game. Having a central clearing house would not make the risk go away. It would only shift the risk from one counter-party to the clearing house.

Capital adequacy norms for banks currently require no capital to be held for derivative contracts which are exchange (i.e. central clearing house) traded. Given the scale of derivatives trading, even the central clearing houses would have had a tough time in settling defaulted transactions, no matter how much collateral had been posted prior to Lehman and AIG having 'credit events'.

And, talking of 'credit events', one needs to understand to what extent, if any, would putting AIG into a Conservatorship be considered a 'credit event' in the ISDA contracts.

The wild swings in the market are a bad sign. We have yet to see the actual results of this week's chaos but I am afraid that people will start acting according to their judgement of the situation prematurely which could affect the markets even more negatively. I'm glad that many institutions and organizations are taking steps against those who are short selling companies that are in trouble.